Despite Shenzhen Xunjiexing Technology Corp. Ltd.'s (SHSE:688655) most recent earnings report having soft headline numbers, its stock has had a positive performance. We did some analysis and found some positive factors that investors might be paying attention to rather than profit.
A Closer Look At Shenzhen Xunjiexing Technology's Earnings
In high finance, the key ratio used to measure how well a company converts reported profits into free cash flow (FCF) is the accrual ratio (from cashflow). To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. The ratio shows us how much a company's profit exceeds its FCF.
As a result, a negative accrual ratio is a positive for the company, and a positive accrual ratio is a negative. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. That's because some academic studies have suggested that high accruals ratios tend to lead to lower profit or less profit growth.
For the year to December 2023, Shenzhen Xunjiexing Technology had an accrual ratio of 0.30. Therefore, we know that it's free cashflow was significantly lower than its statutory profit, raising questions about how useful that profit figure really is. Over the last year it actually had negative free cash flow of CN¥142m, in contrast to the aforementioned profit of CN¥13.5m. We saw that FCF was CN¥9.2m a year ago though, so Shenzhen Xunjiexing Technology has at least been able to generate positive FCF in the past. However, we can see that a recent tax benefit, along with unusual items, have impacted its statutory profit, and therefore its accrual ratio.
Note: we always recommend investors check balance sheet strength. Click here to be taken to our balance sheet analysis of Shenzhen Xunjiexing Technology.
The Impact Of Unusual Items On Profit
Shenzhen Xunjiexing Technology's profit suffered from unusual items, which reduced profit by CN¥2.3m in the last twelve months. In the case where this was a non-cash charge it would have made it easier to have high cash conversion, so it's surprising that the accrual ratio tells a different story. It's never great to see unusual items costing the company profits, but on the upside, things might improve sooner rather than later. We looked at thousands of listed companies and found that unusual items are very often one-off in nature. And that's hardly a surprise given these line items are considered unusual. If Shenzhen Xunjiexing Technology doesn't see those unusual expenses repeat, then all else being equal we'd expect its profit to increase over the coming year.
An Unusual Tax Situation
Moving on from the accrual ratio, we note that Shenzhen Xunjiexing Technology profited from a tax benefit which contributed CN¥2.7m to profit. This is of course a bit out of the ordinary, given it is more common for companies to be paying tax than receiving tax benefits! Of course, prima facie it's great to receive a tax benefit. However, the devil in the detail is that these kind of benefits only impact in the year they are booked, and are often one-off in nature. In the likely event the tax benefit is not repeated, we'd expect to see its statutory profit levels drop, at least in the absence of strong growth.
Our Take On Shenzhen Xunjiexing Technology's Profit Performance
Summing up, Shenzhen Xunjiexing Technology's unusual items suggest that its statutory earnings were temporarily depressed, while its tax benefit is having the opposite effect, and its accrual ratio indicates a lack of free cash flow relative to profit. After taking into account all the aforementioned observations we think that Shenzhen Xunjiexing Technology's profits probably give a generous impression of its sustainable level of profitability. If you'd like to know more about Shenzhen Xunjiexing Technology as a business, it's important to be aware of any risks it's facing. Every company has risks, and we've spotted 5 warning signs for Shenzhen Xunjiexing Technology (of which 3 are a bit concerning!) you should know about.
In this article we've looked at a number of factors that can impair the utility of profit numbers, and we've come away cautious. But there is always more to discover if you are capable of focussing your mind on minutiae. For example, many people consider a high return on equity as an indication of favorable business economics, while others like to 'follow the money' and search out stocks that insiders are buying. While it might take a little research on your behalf, you may find this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying to be useful.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
